Defining Transshipment by Value Content 'Next Shoe to Drop'

Commerce Secretary Howard Lutnick recently threw out an example that if a Vietnamese good had 30% or more Chinese content, it would be classified as Chinese. Thailand's chief trade negotiator complained to reporters in that country in July that the U.S. would require 60%, 70% or even 80% local content, according to a Bloomberg story on what the administration means by "transshipment."

Thompson Hine's Dan Ujczo, who has communication with the Trump administration, said, "To me, that [definition] is the largest issue in the trade agenda."

He said that if Southeast Asian countries are required to reduce Chinese inputs to qualify for 19% or 20% tariffs, "that, there, is ally-shoring on steroids." It would transform global trade, he said.

However, "I just don’t know if it’s practically doable."

The difficulty of achieving a value content standard of this kind is not just one issue. The Indonesian-U.S. joint statement said: "The United States and Indonesia will negotiate facilitative rules of origin that ensure that the benefits of the agreement accrue primarily to the United States and Indonesia."

So, the countries asked to reduce reliance on Chinese inputs have to agree to a number. He said he doesn't see how they could agree to a 70% local content standard, much less 80%. "I don't think most of their goods will meet that content requirement," he said in a phone interview. He said that when he saw the announcements, he thought, "Dear God, how could that not be resolved as an issue between the parties?"

But even once there is a number, how can it be enforced?

Trade attorney John Peterson, of Neville Peterson, said a percentage can be calculated in different ways -- is it based on the cost of the materials? The cost of manufacturing? The value added from the manufacturing?

"You’ll have different companies that have different cost accounting methods," he said, and how do you calculate overhead? What if the Vietnamese factory is owned by a Chinese company, and the Chinese inputs are intra-firm trade?

"The rule can be objective, but not necessarily logical for every case," Peterson said in a phone interview.

"Rules of origin are a much more complicated area than people give them credit for. Something that may cost very little may add a great deal of value to a product."

He added, "When you say, okay, we’re going to judge by your numbers on the books -- then you’re giving people an incentive to cook the books."

Peterson won a court challenge of CBP's assessment in Cyber Power that assembly of power strips in the Philippines did not confer origin, the Chinese components did, and he has complained about the squishiness of "character" and "essential" standards the agency uses. But he doesn't believe a value content benchmark is more objective.

"The main character and use test, it’s the worst test of origin of all, except for all the others," he said.

Ujczo said the fact that companies don't know how the U.S. will define transshipment means the country-specific reciprocal tariff rates announced Aug. 7 don't really settle the uncertainty that has gripped importers since the first emergency tariffs began.

He said sourcing managers that are getting a 19% rate on Indonesian goods, plus most favored nation tariffs, "they have no idea there’s a potential regional value content coming that .... changes the entire calculus at that point."

If a good is judged by CBP to be transshipped, it will owe a reciprocal duty of 40%, plus any penalties and any other tariffs that may apply.

Trying to determine the value content of imported goods will be a heavy lift for CBP, he said.

"We’re not talking about finding needles in the haystack. You're talking about entire sewing shops. CBP is going to need a significant amount of increased resources to make this work.

"I think that what we’ll see is something very similar to the Uyghur Forced Labor Prevention Act, where CBP focuses on particular products and countries early on and makes an example."

There will be cheating, he said. "The incentives are much too large" to get assigned a lower tariff.

But, he said, if the value content rules are limited to Southeast Asia, "U.S. importers may decide: 'It’s just too complicated. Let’s go with a safe country.'"

A former career negotiator in the Office of the U.S. Trade Representative, Wendy Cutler, on a webinar last week said that if negotiations stall over regional value content with Indonesia, the administration "may just announce at least 60% local content and no Chinese content."

"I just think another shoe's going to drop on the rule-of-origin question," she said.

The prospect of a rule that doesn't allow any Chinese content is unworkable, Peterson believes. "Good luck with that," he said dryly.

Peterson doesn't think that creating a rule of origin for non-preferential trade is something CBP can do without formal rulemaking. He knows that the secretary of state issued a statement that tariff policy is exempted from the Administrative Procedure Act, but he doesn't think that holds water.

"For Customs to come up with rules to decide whether a tax can be imposed, it’s blatantly unconstitutional," he said. And, if you're going to have a rule for when 40%+Chinese MFN, fentanyl tariffs and Section 301 duties apply, "it has to be uniform. So you can’t have Customs saying it’s an ad hoc rule for a series of factors."

"I absolutely think you have to have APA rulemaking on this one. There has to be a vehicle for public input.

"Without that, you're going to say: 'Okay, we’re going to punish China.' Fine. Is it just x percent Chinese content that gets you into the Chinese rate, or is it all countries?"

He said what if the final production is in a country with a 30% reciprocal tariff, but the largest contributor of value is from a country with a 10% rate?

He said he thinks companies will sue if CBP constructs a definition of transshipment based on regional value without doing formal rulemaking. He also thinks, in addition to the lawsuits on the legality of the reciprocal program, Brazil tariffs and fentanyl tariffs, there will be lawsuits on the bilateral deals, since they are not going before Congress and getting implementing legislation there.

"My personal opinion is everything that’s being done right now is extralegal and should be swept away," he said. "Basically, this president is hauling us back into the 19th century."

Ujczo, who is sympathetic to the administration's aims to bolster domestic manufacturing and decouple from China, said the approach has been scattershot.

"How much damage is done during those months, I don’t know. They say this is a natural experiment right now."

Peterson said, "The speed of this, it’s just not sustainable for businesses. They don’t know how to plan, they don’t know where to manufacture. It’s a crazy train, and I’m riding it 17 hours a day."